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Business has always been
plagued by fraud: witness the South Sea Company in the 1710s
(which enveloped the British economy in a giant bubble) or
Charles Ponzi's Securities Exchange Company in 1920 (which gave
the world the Ponzi scheme) or the Enron and WorldCom scandals in
the early 2000s.

Ambitious fraudsters are
attracted to businesses for the same reason that Willie Sutton, a
contemporary of Ponzi, reportedly said he robbed banks: "Because
that's where the money is."

Some frauds are committed by people at the top such as Bernard
Madoff or Allen Stanford. Others are committed by hired-hands
lower down the organisation. But all frauds involve abusing
people's trust and diverting corporate resources for personal
ends. Fraud by wayward employees, be they high or low, can never
be eliminated. Directors and executives can, however, treat it
like any other unavoidable risk, and manage it professionally.

The risk is particularly acute at the moment. Companies are
straining the bonds of loyalty. They are making ever more use of
contractors and temporary workers. They are putting more pressure
on employees to hit targets; they are also holding down the wages
of the majority of workers while increasing the boss's pay. This
is all happening at a time when economic activity is shifting to
the emerging world (where corporate fraud is rife) and to the
internet (where fraudsters are having a field day). Kroll, a
security consultant, found that 70% of the companies that it
studied were affected by fraud in 2013, up from 61% in the
previous year.

At the same time the punishment is harsher than ever. Companies
nowadays run the risk of being held liable for their employees'
misbehaviour unless they can show they had done their best to
prevent it. Directors who play even the smallest role in frauds
can now go to prison. America's Foreign Corrupt Practices Act and
its European imitators have made a serious crime of something
once seen as normal business practice: bribing foreigners.
Companies infected by fraud can incur all sorts of other costs.
Their licences to trade may be withdrawn, they may be barred from
bidding for government work and they may be subjected to online
campaigns urging customers to boycott them.

What can companies do to uncover internal scams? A new book,
"Corporate Fraud: the Human Factor", by Maryam Hussain, an
investigator atEY, an accounting firm, provides a timely guide.
One answer is to look for the telltale signs. Some of the biggest
corporate tricksters were people whose flamboyant personalities
often raised suspicions: think of Robert Maxwell, or Augustus
Melmotte in Anthony Trollope's "The Way We Live Now", perhaps the
best novel about corporate fraud. Boards have a duty to pluck up
the courage to challenge such larger-than-life bosses.

However, most corporate fraudsters do not have swishing reptilian
tails as a giveaway sign. In many instances they are not
borderline psychopaths, just ordinary people gone wrong.
Frequently, they start with small crimes and then engage in ever
bigger misdemeanours to conceal their wrongdoing. Nick Leeson,
who destroyed Barings Bank by losing £862m in bad bets on
derivatives, said, "It all started when I tried to cover for a
junior colleague who had lost £20,000." Ramalinga Raju, the
chairman of Satyam, who admitted to inflating the
computer-services company's revenues by $1 billion, said, "It was
like riding a tiger, not knowing how to get off without being
eaten."

A second answer is to put procedures in place to detect frauds.
The Sarbanes-Oxley law passed in America after the Enron and
WorldCom frauds requires the boards of public companies to
commission independent audits of their internal financial
controls. But rigorous procedures can easily lure companies into
a false sense of security. The employees most affected by those
rules may be precisely the ones most capable of finding ways
around them, as was the case with Mr Leeson and Jérôme Kerviel, a
renegade trader at Société Générale.

Many companies seek reassurance that all is well by installing
cyber-security tools to monitor employees' e-mails and internal
accounting systems for suspicious activity. But fraudsters are
often quicker at harnessing technology to disguise what they are
up to (for instance, using instant messaging on their smartphones
as a back-channel to communicate with accomplices) than companies
are at using it to spot them. Those running scams may also be
skilled at tricking colleagues into giving them passwords--a
technique Edward Snowden may have exploited to devastating
effect.

Praising the bearers of bad news

The most powerful weapon against fraud is not an algorithm or a
checklist but a whistleblower. The Association of Certified Fraud
Examiners calculates that three times as many frauds are
discovered by tip-offs than by any other method. It also notes
that firms with fraud hotlines, which staff can call anonymously,
suffer smaller losses from fraud, and cut by seven months the
"exposure gap" between the start of an illicit scheme and its
discovery. Governments are increasingly providing whistleblowers
with legal protection and financial incentives: America's
Securities and Exchange Commission has created a $450m fund to
reward them.

Companies that dither, blather or launch half-hearted inquiries
when presented with evidence of employee misconduct often end up
regretting it. JPMorgan Chase lost billions in its "London Whale"
rogue-trader scandal, initially dismissed by the bank's boss,
Jamie Dimon, as a "tempest in a teapot". Besides doing more to
encourage whistleblowers, businesses must take decisive action to
close the exposure gap. A botched investigation can tip off a
fraudster and make it easy for him to cover his tracks. A
suspicion of deliberate foot-dragging can render an entire
company vulnerable. The damage done by corporate fraud can last
long after the culprits have been identified.